Risks and Solutions Associated with Pension Schemes

Pension schemes, particularly DB schemes, carry risks related to demographic and financial assumptions, investment returns, discount rates, and accounting standards. This article delves into the challenges faced by both scheme members and employers, offering insights on risk reduction strategies and alternative options to scheme closure.

• Pension schemes
• Risks
• Demographic assumptions
• Financial assumptions
• Investment returns

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1. WALKERS SOLICITORS W

2. WALKERS SOLICITORS W

3. What are the risks associated with a DB pension scheme? Demographic assumptions: Life expectancy determines how long a pension will be paid. DB benefits are guaranteed, and might still be in payment 50 years from now. Financial assumptions: Inflation determines the cost of increasing benefits which are inflation-linked. If there is any risk that the future does not turn out to hold what we thought, that risk falls on the employer. Salary inflation determines the cost of final salary benefits. Investment returns ... WALKERS SOLICITORS w

4. The discount rate is determined by taking a view on the investment return that the scheme s assets will achieve. Investment returns: the discount rate To value a pension scheme s liabilities, the cost of paying future instalments of pension to a present value must be assessed. Investing cautiously minimises the risk of volatile returns, at the cost of achieving better returns. If I have to pay you 100 in 10 years time, how much do I need to hold now? The Northern Bank scheme is very cautiously invested. WALKERS SOLICITORS w

5. The Banks accounting issues The accounting standard discount rate is determined by investment grade corporate bonds linked to gilt yields which are at an all-time low. The Bank has to present its accounts on the basis of an international accounting standard. The Bank s presentations of the scheme s surplus/deficit have been measured by reference to the accounting standard. It seems to be committed to delivering a return on equity of 12.5%. It has to meet capital adequacy requirements which are also driven by the accounting basis. What is actually driving the Bank s proposal? WALKERS SOLICITORS w

6. Reducing or eliminating risk In the world of DC, all of the risk is borne by members: Investment returns: what is your individual pot invested in? Risk does not go away. When you retire how long will you live for? It s a question of who bears it. What will inflation do during your retirement? If you don t purchase an annuity you are effectively self- insuring. WALKERS SOLICITORS w

7. Is there another option? We have asked for detailed information regarding the scheme s investment strategy, funding position and actuarial and investment advice. The Bank s position is not unique. Other organisations, including banks, are retaining open DB schemes. Once we have that we will present alternatives to closing the scheme. The Bank has not made a convincing case that its only choice is closure. WALKERS SOLICITORS w

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9. Naimhs illustration Scheme continues DC for the future Naimh takes cash DC for the future Naimh buys an annuity DB pension 12,600 6,800 6,800 DC pension 0 0 4,300 Naimh will be 45 by 30 September 2018 Total pension 12,600 6,800 11,100 DB cash 83,900 45,100 45,100 She will have completed 25 years pensionable service DC cash tax free 0 32,200 32,200 DC cash - taxed 0 96,600 0 Total cash 83,900 173,900 77,300 Her current salary is 22,500 p.a. WALKERS SOLICITORS w

10. Clarification required Scheme continues DC for the future Naimh buys an annuity Pension from past service Pension from future service Total pension DB 7,800 DB 6,800 No change scenario: DB 6,700 ? It would be helpful to show DB pension before and after 1 October 2018 separately. 14,500 DB pension for service after that date will be bigger if the scheme is not closed because it increases in line with the RPI (CARE benefits) or salary not CPI. Cash from past service 52,000 45,500 DB cash is provided by converting ( commuting ) pension into cash. The illustration uses a commutation factor of 20 for each 1 of pension surrendered, but commutation factors are age- related. What are the actual factors used? Cash from future service 44,000 ? Total cash 96,000 WALKERS SOLICITORS w

11. Scheme continues DC for the future Naimh takes cash DC for the future Naimh buys an annuity Clarification required Pension from past service DB 7,800 DB 6,800 DB 6,800 New scenario, and Naimh buys an annuity: Pension from future service DB 6,700 0 DC 3,000 Total pension 14,500 6,800 9,800 The illustrated annuity does not increase, and there is no attached partner s pension. For clarity, the illustrative DC annuity should include both. Cash from past service DB 52,000 45,100 DB 45,100 Cash from future service tax-free DB 44,000 32,200 DC 32,200 New scenario, and Naimh takes her DC benefits as cash: 96,600 The illustration points out that some of the cash will be taxed but the effect of taxation is not spelled out. Is Naimh a basic rate taxpayer? Cash from future service taxed 0 0 173,900 Total cash 96,000 77,300 Is a 6% investment return realistic? WALKERS SOLICITORS w

12. A health warning The illustration assumes that salary and RPI increases are 1% higher than CPI increases. These figures have not been precisely calculated. They are intended to give an early warning. The DC annuity is approximate and uses current annuity rates. But the illustration makes the loss of value of DB pension visible, if the scheme closes. It also makes the poor comparison of a DC annuity with an unchanged DB pension for future service visible. Once we have all of the information we need, our actuaries will provide more accurate illustrations WALKERS SOLICITORS w

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14. Is consent required? Generally contracts of employment will not prevent proposals such as these going ahead. The proposals will require an alteration to the rules. The members guide to the scheme: The Trustee s consent is required. We need to see the legal, actuarial, and investment basis on which it proposes to make any decision. Nothing in this booklet may be taken to override the provisions of the trust deed and rules. The Bank intends to continue the Scheme indefinitely, but has the right to modify its terms, with the consent of the Trustee, or to terminate it. Benefits from past service cannot be reduced, but the link to RPI increases (CARE benefits) and final salary can be terminated. WALKERS SOLICITORS w

15. Consultation In any context, the essence of consultation is the communication of a genuine invitation to give advice and a genuine consideration of that advice. In my view to achieve consultation sufficient information must be supplied by the consulting to the consulted party to enable it to tender helpful advice. The Bank is under a legal obligation to consult you and the Union. Information must be given in such fashion and with such content as are appropriate to enable, in particular, representatives of affected members to consider, conduct a study of, and give their views to the employer on, the impact of the change on such members. (R v Secretary of State for Social Services, ex parte Association of Metropolitan Authorities [1986] ) The Trustee must makes its decision after considering what is in the best interests of scheme members. It is important that they fully understand your point of view. WALKERS SOLICITORS w

16. Ivan Walker Walkers Solicitors WALKERS SOLICITORS w